Fed “Policy Mistakes” – a View from Across the Pond

I have talked at length in recent months about the well-proven limitations of Federal Reserve modeling of the economy. (See for instance “Data-Dependent ... on Imaginary Data.”) And come to think of it, I’ve been on their case for years. The Fed’s predictive capacities are demonstrably abysmal. In today’s Outside the Box, Ambrose Evans-Pritchard, the intrepid international business editor of the Daily Telegraph of London, joins the fray.

Ambrose’s criticism of the Fed’s current posture on policy rates and the drawing down of the Fed’s balance sheet center on three areas of concern:

  1. The forward curve for the one-month Overnight Index Swap rate (OIS), which is a market proxy for the Fed policy rate, has flattened and inverted two years ahead. Ambrose notes that Fed officials like to rely on a different signal: the point where the 10-year US Treasury yield drops below the two-year yield. Problem is, this tends to happen several months after the OIS rate curve has already inverted. By then it’s often too late.

  1. The Fed’s tightening is putting the squeeze on the money supply.

  1. On the global front US rate rises are in effect being magnified, through the mechanism of LIBOR (the London Interbank Offered Rate). Three-month LIBOR – used to set the cost of borrowing on $9 trillion of US and global loans, and $200 trillion of derivatives – has surged 60 basis points since January, and the LIBOR-OIS spread (or LOIS) has widened. The last time that happened – to disastrous effect – was 2007.

To add to what Ambrose is saying, it is just not the last 90 days that LIBOR has surged. It was only a few years ago that LIBOR was under 0.25%. Today it is 2.3%. That is a 2% jump since the Fed’s tightening cycle began. That increase has raised rates on an enormous number of adjustable-rate mortgages and all manner of loans pegged to LIBOR. Note the graph below:

Source: St. Louis Fed

Ambrose concludes by placing these developments in the context of evidence that US, European, and Chinese growth may all be slowing. Yet, he wryly observes,

There is no sign yet that the Fed is having second thoughts about the wisdom of charging ahead with sabers drawn.  The new chairman, Jay Powell, was strikingly hawkish in a recent speech, making it clear that he has no intention of bailing out Wall Street if equities tumble or credit spreads widen. He dismissed short-term shifts in the economy as meaningless noise.

Poor Chairman Powell. Janet Yellen rides off into the sunset and leaves him with a true upside-down mess. Fed rates are 1.625% and inflation is at 2.1%. Essentially we have 50 basis points of negative real interest rates. Jay knows he has to continue to tighten under these circumstances. But he also knows exactly what he’s risking. As the saying goes, he’s in between the devil and the deep blue sea. The heavily Democratically biased Yellen Fed simply did not step up and do their job when the economy was doing well, out of fear of going too far. The moment Trump was elected they got religion about rates – at least three years too late. And Powell get stuck with the Old Maid. (For non-US readers, Old Maid is a children’s card game with one card, the Old Maid, that you don’t want to have in your hand at the end of the game, so you try to pass it off to your fellow players. If you get stuck with the Old Maid, you lose. I think Powell could lose.)

This is important stuff. We’re marching straight into the jaws of what, in last week’s Thoughts from the Frontline, I called the Great Reset. It’s one thing to boldly charge ahead on the policy front but quite another to head off the next global recession, born of chronic monetary and fiscal malfeasance.

By the way, as I was reviewing my information sources the other day, something interesting occurred to me: Some of the best US economic analysis comes from outside the US. In theory, we should have a better grip on our own central bank and government, right? But in fact, my friends in Canada, Europe, Asia and elsewhere deliver consistently cogent thoughts as well. I haven’t done a formal tally, but I suspect I rely on them at least as much as I do on US sources.

Why is that? Maybe it’s because distance gives you a different perspective. Non-Americans aren’t burdened with our cultural assumptions and can look just at the facts. They see things we Americans miss because to us they’re just part of the landscape.

This underscores the importance of having both many information sources and the right sources. And you still have to prioritize, because none of us can read everything that competes for our views. I’ve figured out ways to deal with these issues, and I’ll be sharing them with you. Details soon.

I find myself in Charlotte, North Carolina, where I’m speaking for the S&P Forum. Semi-randomly, good friend Rory Riggs is in town, and we will have lunch in a few minutes. You’re going to hear that name a lot from me over the next few years. He is getting ready to set the investment industry on its ear. Stay tuned…

Your worried about monetary policy mistakes analyst,

John Mauldin, Editor
Outside the Box
JP Morgan fears Fed “policy mistake” as  
US yield curve inverts

By Ambrose Evans-Pritchard,

The Telegraph

The US credit markets are flashing a rare warning of economic trouble ahead, signalling that the Federal Reserve risks blundering into another recession without a deft change of course.

A blizzard of surprisingly poor data across the world suggests that the Fed’s liquidity squeeze is taking a greater toll than widely assumed, and that the institution’s staff model has so far failed to pick up the danger signs.

US jobs growth fizzled to stall-speed levels of 103,000 in March. The worldwide PMI gauge of manufacturing and services has dropped to a 14-month low. The average “Nowcast” tracker of global growth has slid suddenly to a quarterly rate of 3.2pc from 4.1pc as recently as early February.

Analysts at JP Morgan say the forward curve for the one-month Overnight Index Swap rate (OIS) – a market proxy for the Fed policy rate – has flattened and “inverted” two years ahead. This is a collective bet by big institutional investors and fund managers that interest rates may be falling by then.

It is a market verdict that Fed officials have lost touch with reality in thinking that they can safely raise rates another seven times to 3.5pc by late 2019, as implied by the “dot plot” forecast. It is tantamount to a recession warning.

“An inversion at the front end of the US curve is a significant market development, not least because it occurs rather rarely. It is generally perceived as a bad omen for risky markets,” said Nikolaos Panigirtzoglou, JP Morgan’s market strategist.

“Markets have started pricing in a Fed policy mistake or have started pricing in end-of-cycle dynamics,” he said. Both possibilities are disturbing.

The OIS yield curve has inverted three times over the last two decades. In 1998 it proved to be a false alarm because the Greenspan Fed did a pirouette and flooded the system with liquidity. In 2000 it was a clear precursor of recession. In 2005 it signaled that the US housing boom was already starting to deflate.

Fed officials tend to watch a different signal – the moment when the 10-year US Treasury yield drops below the two-year yield – deeming this the best single predictor of recessions in a study last month by the San Francisco Fed.  

This has not yet been triggered. The problem is that this tends to happen several months after the OIS rate curve has already inverted. By then it is often too late. Trouble is already baked into the pie.

“We think that the current expansion will begin to fizzle out before long. US equities are likely to suffer once the US economy stalls, and a weaker US stock market would almost certainly be contagious, especially if growth in the rest of the world also faltered,” said Finn McLaughlin from Capital Economics.

The Fed’s monetary tightening is now biting hard. Growth of the “broad” M3 money supply in the US has slowed to a 2pc rate over the last three months (annualised) as the Fed shrinks its $4.4 trillion (£3.1 trillion) balance sheet, close to stall speed and pointing to a “growth recession” by early 2019. Narrow real M1 money has actually contracted slightly since November.  

This suggests that the reversal of quantitative easing may matter more than generally appreciated. The Fed’s bond sales have been running at a pace of $20bn a month. This rises to $30bn this month, reaching $50bn by the fourth quarter. RBC Capital Markets says this will drain M3 money by roughly $300bn a year, ceteris paribus.

What worries monetarists is that the Fed intends to step up the pace of quantitative tightening (QT) regardless of the monetary slowdown. The institution adheres closely to a New Keynesian “creditist” model and pays little attention to monetary aggregates. This proved a costly mistake in 2008.

US rate rises are having a parallel effect, but through a different mechanism. Three-month Libor rates – used to set the cost of borrowing on $9 trillion of US and global loans, and $200 trillion of derivatives – have surged 60 basis points since January.

There is no sign yet that the Fed is having second thoughts about the wisdom of charging ahead with sabers drawn.  The new chairman, Jay Powell, was strikingly hawkish in a recent speech, making it clear that he has no intention of bailing out Wall Street if equities tumble or credit spreads widen. He dismissed short-term shifts in the economy as meaningless noise.

The Fed view is that Donald Trump’s unwarranted fiscal stimulus – lifting the budget deficit to 5pc of GDP at the top of the cycle – is inflationary and increases the risk of over-heating.

The signs of a slowdown are even clearer in Europe where the low-hanging fruit of post-depression recovery has largely been picked and the boom is fizzling out, exposing the underlying fragilities of a banking system with €1 trillion of lingering bad debts.

Citigroup’s economic surprise index for the region has seen the worst four-month deterioration since 2008.  A reduction in the pace of QE from $80bn to $30bn a month has removed a key prop. The European Central Bank’s bond purchase programme expires altogether in September.

What is surprising is that Germany is slowing hard despite a seriously undervalued currency (for Germany, not for France or Italy). Industrial output has contracted over the last three months and exports suffered the steepest dive for three years in February.

Germany is highly leveraged to the Chinese industrial cycle so this may be a sign that Chinese growth has slowed more than the authorities admit – as indicated by plummeting yields on Chinese bonds, and rates on three-month Shibor and certificates of deposit.

The world economy was coming off the boil even before President Trump launched an escalating trade war against China. The global money supply has been slowing since last September. The Baltic Dry Index measuring freight rates for dry goods peaked in mid-December and has since dropped 45pc.

The Fed, the ECB, and the global authorities insist that this is a temporary “air pocket”, and that synchronized world growth is alive and well. The bond markets do not entirely believe them.

The Global Trade Game

Mohamed A. El-Erian

CAMBRIDGE – The trade confrontation between the United States and China is heating up.

After firing an opening salvo of steep tariffs on steel and aluminum, the US administration has released a plan for a 25% tariff on 1,333 Chinese imports – worth about $50 billion last year – to punish China for what it views as decades of intellectual property theft. China has fired back with a plan to slap 25% levies on a range of US goods, also worth about $50 billion. In response to what he labels “unfair retaliation,” US President Donald Trump is now said to be considering yet another set of tariffs, covering another $100 billion worth of imports from China. Economists and market analysts are scrambling to figure out what will come next.

One might be tempted to rely on historical experience. But, given today’s economic, political, and social conditions, history is likely to be a poor guide. More useful insights come from game theory, which can help us to determine whether this exchange of tariffs will ultimately amount to strategic posturing that leads to a more “cooperative game” (freer and fairer trade), or develop into a wider “non-cooperative game” (an outright trade war). The answer will have significant consequences for the economic and policy outlook, and markets prospects.

The rapid expansion of trade in recent decades has given rise to a web of cross-border inter-dependencies in production and consumption. Supply chains now can have as many significant international links as domestic ones, and a substantial share of internal demand is being met by products partly or wholly produced abroad. As technological innovation further reduces entry barriers for both producers and consumers, the proliferation of these linkages becomes even easier, amplifying what already is essentially a spaghetti bowl of cross-border relationships and dependencies.1

For the longer-term health of both individual participants and the overall system, these relationships must function effectively, based on a cooperative approach that is deemed credible. If not, they risk resulting in a lower level of growth and welfare. This is why the current confrontation between the US and China has raised fears of serious damage, particularly if it leads to ever-greater protectionism and a wider “trade war.” But this outcome is not guaranteed.

For international economic interactions to work well, they must also be viewed as fair. That is currently not the case among many segments of the global population. As it turns out, two key assumptions on which the virtually unfettered pursuit of economic (and financial) globalization has been based in recent decades have turned out to be over-simplifications.

The first assumption was that the benefits of trade would naturally be shared by most of the population, either directly or because of appropriate redistribution policies implemented in the now-faster growing economies. Second, it was assumed that the major participants in global trade – including the emerging economies that joined this process and, later, its anchoring institutions, such as the World Trade Organization – would eventually embrace the basic principles of reciprocity, continuing gradually to reduce both tariff and non-tariff barriers.

As these assumptions have proved to be excessively optimistic, the standing and sustainability of pro-trade policies have suffered. The result has been a marked rise in nationalist populism – a trend that has led to new trade restrictions, the ongoing re-negotiation of existing arrangements (such as the North American Free Trade Agreement), and a backlash against supranational institutions (such as the United Kingdom’s vote to exit the European Union).

So what about the next steps? As currently set up, the international economic order needs to function as a cooperative game, in which each participant commits to free and fair trade; the commitments are credible and verifiable; mechanisms are in place to facilitate and monitor collaboration; and cheaters face effective penalties.

Current trade tensions could conceivably destroy this cooperative game, triggering a shift to a non-cooperative one, with elements of a “prisoner’s dilemma,” in which self-interested action turns out to be both individually and mutually destructive. But, given that this would mean losses for virtually all countries, it may be possible to avoid it, with the help of a few targeted policy responses.

For starters, systemically important but not sufficiently open countries – beginning with China – should liberalize their economies more rapidly (particularly by reducing non-tariff barriers) and adhere to internationally accepted norms on intellectual property. Moreover, existing trade arrangements should be modernized as needed, so that they better reflect current and future realities, while companies and others that benefit disproportionately from trade should intensify their pursuit of socially responsible activities. Multilateral surveillance and reconciliation mechanisms – not just at the WTO, but also at the International Monetary Fund and the World Bank – should be revamped, and the functioning of the G-20 should be improved, including through the establishment of a small secretariat that facilitates greater policy continuity from year to year.

Given how many countries have an interest in maintaining a cooperative game, such policy actions are not just desirable; they may be feasible. As they help to create a stronger cooperative foundation for fairer trade, these measures would also constitute a necessary (though not sufficient) step toward countering the alienation and marginalization of certain segments of the population in both advanced and emerging economies.

Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers in 2009, 2010, 2011, and 2012. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.

The West Rebukes Russia in Syria

By Jacob L. Shapiro


Late last week, the U.S., U.K. and France launched coordinated missile strikes on select regime targets in Syria. It was the second time the Trump administration had ordered strikes on the Assad regime, and only two things distinguish last week’s strikes from the ones that were carried out a year ago: Twice as many missiles were fired in the most recent attack, and the U.K. and France participated. But the strikes will not change the Syrian war. They were driven mainly by domestic politics in the three countries involved, which have emphasized both that regime change is not their goal and that Russia is partly responsible for Bashar Assad’s actions.
Four Powers
There are now four global powers intervening in Syria: Russia, the U.S., the U.K. and France. Russia ventured south to distract from problems at home. The U.S., which intervened initially to try to destroy the Islamic State, has struck Assad twice, mainly because President Donald Trump does not want to be compared to former President Barack Obama, who didn’t enforce his own red line on Assad’s use of chemical weapons. The U.K. has latched on to Russia as Europe’s boogeyman and is using both diplomatic expulsions and now airstrikes against a Russian client state to distract from contentious Brexit negotiations, which as recently as a few months ago threatened to bring down Prime Minister Theresa May’s government. France, which is dealing with crippling labor unrest and a president, Emmanuel Macron, with rapidly declining popularity ratings, wants to hide what everyone already knows: France has become Germany’s junior partner in the EU.

All four are equally unprepared for a war over Assad’s alleged use of chemical weapons. The U.S. is desperately searching for a way to leave Syria. The U.K. and France are hardly willing to deploy the type of military force that would be necessary to bring down the Assad regime, much less militarily confront Russia. Russia’s Syria deployment has always been limited, concentrated mostly on air assets to help the Assad regime defeat rebels who can’t challenge Russia in the skies. This is not Desert Storm, nor is it a prelude to World War III. It is foreign powers doing what they’ve always done in the Middle East: pushing pawns around on a chessboard to make a point to each other and even to themselves.

Meanwhile, the real players in this war were remarkably quiet over the weekend. Israel, which has bombed Assad regime targets and Iranian targets in Syria multiple times, reportedly supplied some intelligence on Syrian chemical weapons facilities but otherwise did not participate in the expedition. (A blast at a Hezbollah base south of Aleppo over the weekend appears to have been a weapons depot explosion and not an Israeli air attack, as many news outlets reported.) Turkey was busy mediating between Russia and the United States right up until the missiles started falling. Iran called the attacks a crime but has confined its vengeance to rhetorical flourishes thus far.

The Syrian civil war may yet morph into a much larger conflagration – but if that happens, it will be because of a clash of Turkish-Iranian interests, not because of limited Western airstrikes on Assad’s chemical weapons facilities. While Russia and the U.S. exchange condemnations at the U.N., the Assad regime will continue to mop up the opposition; Turkey will continue its incursion into northern Syria; Iran will continue building bases and strengthening proxies throughout the country; Israel will apply its deterrence strategy to a much larger target; and the Syrian Kurds will inch closer to the inevitable moment that they are hung out to dry by their patron – the U.S. – which no longer has a use for them. The sooner the threat of Western airstrikes abates, the sooner the belligerents can get back to the real fighting.
An Anti-Russia Coalition
But Western powers insist that they will continue to intervene so long as the Assad regime continues to use chemical weapons. Something here has never quite added up. There is little publicly available proof that chemical weapons were used in Douma. The U.S. has said it believes they were, but its track record when it comes to evaluating the presence of weapons of mass destruction in the Middle East leaves something to be desired. Furthermore, coalition airstrikes started shortly before investigators from the Organization for the Prohibition of Chemical Weapons arrived in Damascus. The timing of the Western strikes – which were delayed to give Russia an opportunity to remove its forces from harm’s way – is thus confusing, considering that launching the strikes before the investigation could be carried out gives Russia a useful talking point.

Moreover, there is little reason for the Assad regime to use such weapons. It’s too easy to explain this away by insisting that Assad is just a monster – he might be a monster, but he’s been an exceedingly pragmatic one up to this point, and there’s little reason to think that has changed. Assad and his patrons have no motive for using chemical weapons in this case. The regime is on the cusp of securing Damascus – why engage in a chemical attack on a mostly defeated opposition? Using chemical weapons offers little in the way of a military advantage and gives Assad’s enemies a useful pretext to launch attacks. Russia is trying to leave Syria and has been trying to move toward a negotiated settlement for months. Iran’s position in Syria is menacing but weak – it needs time to establish a robust presence and secure its long supply lines – and becoming a Western target is detrimental to its agenda.

Amid this confusion, the one thing that can be said for certain is that an anti-Russia coalition has been defined. The Western strikes did not change the balance of power in the Syrian war, and indeed, they have relatively little to do with the conflict that is grinding Syria into dust and ruin. It seems more likely at this point that the strikes were a political statement against Russia. (Germany was reportedly offered an opportunity to join the strike, but it has a more complicated relationship with Russia than the others do and didn’t want to engage in direct military action against a Russian ally.) The U.S., the U.K. and France may have bombed chemical weapons facilities in Syria, but they also went out of their way to demonize Russia as a menace to the liberal international order.

Our forecast for this year didn’t anticipate that the West and Russia would be clashing to this extent. Russia wants a balance of power in the Middle East, one that keeps Turkey and Iran fighting each other indefinitely, preventing both from becoming powerful enough to challenge Russian interests in its desired spheres of influence. The Western powers also want a balance of power. But old habits die hard. Cold War comparisons, however wrongly applied to the current situation, are understandably compelling in a morally ambiguous conflict. Domestic imperatives also sometimes outweigh international ones. Trump wants to look strong, May needs Europe focused on foreign threats instead of the border with Northern Ireland, and Macron is desperate for a political win – and all can be had at the low cost of bombing insignificant targets in a Middle Eastern pariah. As for Russian President Vladimir Putin, it’s now Moscow versus the West – and a great deal of economic dysfunction can be forgiven if it is suffered in defense of Mother Russia.

There are two wars being fought here: a military war for Syria, and a public relations war between Russia and the West. The airstrikes in Syria were salvos in the latter. The former has no end in sight.

Silver May Be Preparing For Its Strongest Bull Run In Years

By Adam Hamilton


Silver has been dead money over the past year or so, relentlessly grinding sideways to lower. That weak price action has naturally left this classic alternative investment deeply out of favor. Silver is extremely undervalued relative to gold, while speculators’ silver-futures positions are extraordinarily bearish. All this has created the perfect breeding ground to birth a major new silver bull market, which could erupt anytime.

Silver’s price behavior is unusual, making it a challenging investment psychologically. Most of the time silver is maddeningly boring, drifting listlessly for months or sometimes years on end. So the vast majority of investors abandon it and move on, which is exactly what’s happened since late 2016. There’s so little interest in silver these days that even traditional primary silver miners are actively diversifying into gold!

But just when silver is universally left for dead, one of its massive uplegs or bull markets suddenly ignites. Some catalyst, typically a major gold rally, convinces investors to return to silver. Their big capital inflows easily overwhelm the tiny global silver market, catapulting this metal sharply higher. Silver skyrockets to amazing wealth-multiplying gains, dwarfing nearly everything else. This reinvigorates silver’s cult-like following.

Silver’s dominant primary driver has long been gold, which controls all precious-metals sentiment.

When gold isn’t doing anything exciting, silver languishes neglected. But once gold rallies high enough for long enough to convince investors a major upleg is underway, capital starts returning to silver. Thus silver is effectively a leveraged play on gold, amplifying its price action. Silver never soars unless gold is strong.

This psychological relationship is so ironclad it may as well be fundamental. The global silver and gold supply-and-demand profiles are technically independent, with little direct linkage physically.

But when investment demand flares to drive gold higher, parallel silver investment demand soon materializes. So silver and gold often move in lockstep, especially when gold’s price action is interesting enough to catch attention.

All this makes the Silver/Gold Ratio the most-important fundamental measure for silver prices. The lower silver prices happen to be compared to prevailing gold ones, the greater the odds a major silver mean-reversion rally is imminent. And today silver is almost as low relative to gold as it’s ever been in the past century! This first chart looks at the SGR, or more precisely the inverted GSR, over the past 13 years or so.

The SGR calculation results in tiny hard-to-parse decimals, like this week’s 0.012x. So I prefer to use the gold/silver ratio instead, which yielded a cleaner 81.9x as of this Wednesday.

Charting this GSR with its axis scaled upside down produces the same SGR line, but with far-more-brain-friendly numbers. This shows that silver is extremely undervalued relative to gold today, which is super-bullish for this neglected asset.

(Click to enlarge)

Again this week the SGR was running at just 81.9x, meaning it took almost 82 ounces of silver to equal the value of a single ounce of gold. So far in 2018, the SGR has averaged 79.6x. As you can see in this chart, that’s extremely low. There have only been two other times in modern history where silver looked worse relative to gold, late 2008’s first-in-a-century stock panic and early 2016’s secular-bear-market lows.

Because of silver’s tiny market size, it’s an incredibly-speculative asset. When investment capital flows really shift, silver can soar or plunge with shocking violence. Silver’s speculative nature makes it far more susceptible to general market psychology than gold. Silver acts like a small fishing boat battered around in the choppy waves of sentiment, while gold is more like a supertanker punching through them.

That 2008 stock panic was the first since 1907, one of the most-extreme fear events of our lifetimes. Technically a stock panic is a 20 percent+ plummet in the major stock-market indexes in less than two weeks. The flagship S&P 500 stock index indeed collapsed 25.9 percent in exactly two weeks in early October 2008, which terrified everyone. If felt like the world was ending, so investors and speculators sold everything to flee to cash.

Gold weathered that storm well, only sliding 3.3 percent in that wild stock-panic span. But the overpowering fear scared traders into hammering silver 23.7 percent lower. On exceptional stock-market down days, silver tends to split the difference between the S&P 500 and gold. We’ve seen that recently as well, during this new stock-market correction since early February. Silver is particularly sensitive to prevailing herd sentiment.

Between September and December 2008 straddling that stock panic, the SGR averaged just 75.8x. Silver was radically undervalued relative to gold, an anomalous state that has never been sustainable for long. The resulting mean reversion and overshoot higher was enormous, yielding stupendous gains for silver investors. Silver ultimately bottomed at $8.92 per ounce in late-November 2008, at a super-low 83.5x SGR.

Over the next 12.4 months silver rocketed 115.4 percent higher out of those extreme stock-panic lows, which restored the SGR to 63.2x. But that was still low. In the years leading into that stock panic, the SGR averaged 54.9x. For decades a mid-50s SGR has been normal, with silver generally oscillating around those levels compared to gold. Miners had long used 55x as a proxy for calculating silver-equivalent ounces.

Once silver falls to extreme lows relative to its primary driver gold, the inevitable resulting mean reversion rarely stops near the average. Instead it tends to overshoot proportionally to the upside, fueling massive gains. Silver started returning to favor in late 2010 and early 2011 as gold powered to major new highs. That ultimately climaxed with silver enjoying popular-mania-like popularity in late April 2011, at $48.43 per ounce.

That made for a total bull market out of those extreme stock-panic lows of 442.9 percent over 2.4 years! At its peak, the SGR had soared to 31.7x. Silver can’t sustain anomalously-high prices relative to gold either, so that bull soon rolled over as I warned the month before that peak. The key takeaway today is silver’s extreme stock-panic lows birthed a major new bull market. Silver can’t stay crazy-low relative to gold for long.

Unbelievably silver in 2018 is even more extremely undervalued than during those 4 months surrounding that stock panic! Again the SGR is averaging just 79.6x year-to-date. That’s considerably worse than during the stock panic which saw 75.8x over a similar time span. Such incredibly-low silver prices are no more sustainable now than they were then. That’s why a major new silver bull is likely coming very soon.

Interestingly the SGR popped right back up to its traditional mid-50s average after 2008’s stock panic as well. Between 2009 and 2012, the SGR averaged 56.9x. Those were the last quasi-normal years for the markets before the Fed’s unprecedented open-ended third quantitative-easing campaign started to wildly distort everything in 2013. Everything since then is literally a central-bank-conjured illusion that will shatter.

If silver merely mean reverts out of today’s worse-than-stock-panic extreme lows, regaining a 55x SGR would catapult it near $24.25 at this week’s $1333 gold levels. That’s almost 50 percent higher than today’s deep lows! From this week’s wild 81.9x SGR low, a proportional overshoot back up to a 28.1x SGR would blast silver back near $47.50. That’s 191 percent higher from here, nearly a triple, making for big gains.

All it will take to get silver mean reverting is a convincing gold upleg. Investors will return to silver once gold rallies high enough for long enough for them to believe its climb is sustainable. Then silver will take off and amplify gold’s gains. Gold powered 106.2 percent higher during that post-stock-panic silver bull where it soared 442.9 percent, making for 4.2x leverage. Gold also fueled silver’s last reversion rally out of extreme lows.

From 2013 to 2015, the stock markets surged relentlessly as the Fed’s vast QE money creation directly levitated them. Gold is an alternative investment thriving when stock markets weaken, so it was largely abandoned in those weird years. Gold ultimately slumped to a 6.1-year secular low in December 2015 leading into the Fed’s first rate hike of this cycle. That pummeled silver to its own parallel 6.4-year secular low.

In late 2015 silver felt a lot like it does today. No one wanted anything to do with it, everyone believed it was dead. Investors and speculators alike wouldn’t touch silver with a ten-foot pole near those lows, convinced it was doomed to spiral lower indefinitely. Yet out of that very despair a new silver bull was born. Over the next 7.6 months into August 2016, silver powered 50.2 percent higher on gold’s new 28.2 percent upleg.

Unfortunately that new mean-reversion silver bull ended prematurely as gold’s own young bull suffered a temporary truncation. The extreme stock-market rally erupting after Trump’s surprise election victory on euphoric hopes for big tax cuts soon sapped the wind from gold’s sails. So it dragged silver lower during much of the time since. But the new stock-market correction proves that stocks-strong-gold-weak trend is ending.

That’s super-bullish for silver, especially with it trading at stock-panic-like extreme lows compared to where gold is today. As these wildly-overvalued stock markets continue sliding lower on balance, gold will return to favor. The resulting capital inflows driving it higher will get investors and speculators alike interested in silver again. And just like after past extreme lows, their buying will catapult silver sharply higher.
Today’s extreme undervaluation in silver relative to gold is reason enough to expect a major new silver bull to ignite soon and start powering higher. But silver’s bullish outlook gets even better. The silver-futures situation today is nearly as extreme, with speculators making exceedingly-bearish bets on silver. These will have to be reversed as gold rallies, unleashing massive silver buying that will quickly drive it higher.

Short-term silver-price action is dominated by speculators’ silver-futures trading. The extreme leverage inherent in silver futures lets these guys punch way above their weight in terms of silver-price impact. Each silver-futures contract controls 5000 troy ounces of silver, worth $81,400 even at this week’s very-depressed prices. Yet the maintenance margin required to hold a contract was only $3,600 this week!

That means silver-futures speculators can run extreme leverage up to 22.6x, which is outrageous.

Most investors run no leverage at all of course, and the legal limit in the stock markets has been pegged at 2x for decades now. Compared to an investor owning silver outright, each dollar silver-futures speculators are trading can have over 20x the price impact on silver! This gives futures traders wildly-outsized influence.

Every week their collective silver-futures positions are detailed in the CFTC’s famous Commitments of Traders reports. The recent reads are every bit as bullish for silver over the coming months as the SGR is over the coming years! All it will take to get silver surging higher again is for these universally-bearish traders to start buying again. And with the extreme leverage they run, the markets will force them to buy.

This chart shows speculators’ collective long and short positions in silver futures in green and red.

They are now barely long silver while heavily short, making for exceedingly-bearish collective bets.

Those will have to be unwound relatively rapidly once gold’s stock-market-selloff-fueled rally inevitably starts pulling silver higher again. This is the most-bullish silver-futures situation seen since just before silver’s last bull was born!

(Click to enlarge)

Let’s start on the short side, since that’s where speculators’ big silver-futures buying will begin. In the latest CoT week before this essay was published, current to Tuesday March 27th, speculators had total silver-futures shorts of 87.6k contracts. That’s truly extreme. Out of the 1004 CoT weeks since back in early 1999, that’s the 5th-highest spec shorting levels ever seen! Past extremes were never sustainable.

Note above that every single time the red spec-shorts line surged to highs, silver was bottoming ahead of a major rally ignited by short covering. That was true in late 2015 when silver’s latest bull was born, in mid-2017 during gold’s and silver’s summer-doldrums lows, and in late 2017 which saw extreme silver-futures short selling leading into another Fed rate hike. Silver rallied sharply after each shorting spike.

Silver-futures speculators are always wrong at extremes, because their very collective trading is what spawns those extremes in the first place. Once these guys have expended all their capital firepower to throw heavily short silver, there’s no one left to short sell it. Soon some get nervous and start to buy to cover their existing shorts. The only way to exit futures shorts is to buy offsetting long contracts to close positions.

And once short-covering buying starts on the periphery, the whole herd of speculators soon has to join in or risk truly-catastrophic losses. At today’s 22.6x max leverage available in silver futures, a mere 4.4 percent silver rally would wipe out 100 percent of the capital risked shorting it! So as soon as silver starts rallying when speculators are extremely short, they are forced to rush to buy to cover which catapults its price sharply higher.

No matter where the SGR happened to be, the 5th-highest spec shorts in silver-futures history would be wildly bullish for the near-term. But that’s not the whole silver-futures picture. It’s not just the speculators on the short side of the trade that are too bearish on silver, so are the long-side guys. In this latest CoT week, total spec silver-futures longs were only running 95.0k contracts. That’s just over a 26.2-month low!

Speculators’ collective bullish bets on silver via futures are slightly above their lowest levels since early 2016 when silver’s last bull market erupted! Unlike short-side traders who are legally obligated to buy to cover once silver starts rallying, new long-side buying is discretionary. But that very short covering drives silver higher fast enough to make the bearish long-side traders want to buy back in too, amplifying silver’s rally.

There’s nothing more bullish for silver over coming months than the rare combination of extremely-high shorts and very-low longs! This hasn’t been seen since late 2015 around silver’s 6.4-year secular low. Once silver started climbing on a parallel gold rally driven by short covering in its own futures, silver was off to the races on big futures buying. Speculators rushed to cover their excessive shorts and rebuild meager longs.

The resulting 30.0k contracts of silver-futures short-covering buying and another 55.6k of long buying catapulted silver 50.2 percent higher over the next 7.6 months. That adds up to 85.6k contracts of spec silver-futures buying. Today’s situation is even more bullish. If total spec shorts and longs return to their past year’s low and high, we’re looking at 54.5k contacts of short covering and another 59.5k of long buying!

That adds up to colossal silver-futures buying potential of 114.0k contracts over the next half-year or so. That’s the equivalent of a staggering 570m ounces of silver, or nearly 2/3rds of the latest read on annual world silver mine production! The potential silver upside that would be fueled by silver-futures buying of this magnitude is enormous. I suspect the resulting silver bull will dwarf the last +50.2 percent one in 2016’s first half.

Once silver starts rallying decisively on silver-futures buying, investors with their vastly-larger pools of capital will also start returning. Bullish analyses will explode, highlighting silver’s deep undervaluation relative to gold per the Silver/Gold Ratio. That will fuel bullish sentiment driving even more buying. Bull markets’ virtuous circle is buying begetting more buying. The more silver rallies, the more people want to buy it.

I’d be very bullish on silver with only a stock-panic-level SGR, only extreme spec silver-futures shorts, or only very-low spec silver-futures longs. But seeing all three at once, at a time when gold is rallying as the stock markets finally roll over out of their fake central-bank-spawned levitation, is truly extraordinary! This is literally the most-bullish setup for silver seen in years, so smart contrarian traders should be really long.

History proves that once silver starts moving, it will likely rally fast. As always, the biggest gains will be won by the fearless contrarians who bought in early before everyone else figures this out. Investors and speculators alike can play silver’s big coming upside in physical bullion itself, the leading SLV iShares Silver Trust silver ETF, and the silver miners’ stocks. But only the latter will greatly leverage silver’s gains.

Just last week I wrote a comprehensive essay exploring the recent Q4’17 results of the world’s major silver miners included in the leading SIL Global X Silver miners ETF. They are mining silver at average all-in sustaining costs of just $10.16 per ounce, far below even today’s low silver prices. So all of silver’s new-bull-market gains will be pure profit, leading to exploding earnings driving silver miners’ stocks far higher.

During 6.9 months roughly coinciding with early 2016’s silver bull, SIL rocketed 247.8 percent higher! That’s about 4.9x upside leverage to silver’s own gains. And given how absurdly low silver-stock prices are today, silver miners have similar-if-not-greater potential to amplify silver’s even-larger gains in its next bull. The elite major silver miners with superior fundamentals could be the best-performing stocks in all the markets.

The bottom line is a new silver bull is coming. Silver’s long and vexing sideways-to-lower grind has left it as undervalued relative to gold as during 2008’s stock panic. That anomaly was resolved by silver more than quintupling over the subsequent years in a mighty mean-reversion-overshoot bull.

On top of that, silver-futures speculators’ short positions are at extreme highs while their opposing longs are at bull-birthing lows.

These wildly-bearish traders will be forced and motivated to aggressively buy silver futures once silver starts rallying decisively. That will be driven by gold strength like usual. Stock-market weakness ignites gold investment demand, driving both precious metals higher. Today’s silver setup is the most bullish in years. Everything is perfectly aligned for a massive new silver bull market to get underway any day now.

martes, abril 17, 2018



Ideology Is Dead

By Jacob L. Shapiro

Led by the United Kingdom and the United States, more than 20 countries expelled Russian diplomats last week. Moscow promised to respond in kind and has already shown 60 foreign diplomats the door. Commentators in the Western media and the Russian press are breathlessly bandying about the same question: Is the world on the edge of a second Cold War? It is an absurd question for a number of reasons, but I will content myself here to explain just one of them. The Cold War was as much a geopolitical conflict as it was an ideological one. The Soviet Union viewed itself as the vanguard of a global revolution – this was the end that justified the means. The U.S. similarly believed it was unique, a liberal light unto the nations sworn to defend the freedom of every individual.

The same cannot be said today for either. Indeed, it cannot be said that any of the world’s major countries possesses an ideology that animates or justifies its actions. Russia and China no longer pursue global revolution: Russia pursues its national interests in its buffer zones, and China pursues its national interests in its littoral waters. Kim Il Sung’s “juche” in North Korea has become little more than a nuclear weapons program. In Europe, even the most fervent of Europhiles thinks that at a certain point Brussels should mind its own business. As for the U.S., apart from a brief neoconservative soiree in the early 2000s, Washington has been more confused than anything else since 1991. A year and a half of  “Make America Great Again” has meant little more than “Make America More Powerful.”
The Age of Ideology

Ideology had a good run – it ruled for about 52 years, from 1939, the year World War II began. The memory of that war continues to haunt the world. Like the Cold War, World War II was a war of ideology – of liberal democracy, communism, fascism and national liberation (in various combinations depending on the year). In fact, the trope of World War II is still omnipresent today, whether in the “reductio ad Hitlerum” used in any conversation in which someone expresses a sentiment clearly beyond the pale, to the fight over the historical memory of World War II that rages on a seemingly daily basis in headlines. This fight over historical memory continues in Poland over who should be assigned blame for certain war crimes, in South Korea over how to admonish Japan for its wartime atrocities, and in the Middle East, where the one thing Turkey and Iran have in common is that both, at various times, have been compared to Nazi Germany by outsiders.

But the world today does not resemble the ideologically charged world of 1939-91, in part because of how terrified the world is of returning to such times. Indeed, the world today looks a lot more like the world during the decades that preceded a different global conflict – World War I. It was not an ideological war; it was a war for national strength without pretense in a time of rising and falling great powers. Germany no longer wished to chomp at the bit of the British Empire. The U.S. wanted more than anything to be left alone. The Ottomans, the Austro-Hungarians and the Russians were slowly deteriorating and searching for a way to inject vitality into their failing political regimes. Meanwhile, the French were inventing triple cream brie and trying to forget the revolutions and Napoleon. When Archduke Franz Ferdinand was assassinated, the European alliance system was structured in such a way that war was inevitable.

It is possible to trace the outline of a similar power structure in the current world order. A dominant, imperial power – the U.S. – is engaged in a constant game of whack-a-mole to maintain the status quo. Strengthening powers such as China and Turkey chafe at America’s disproportionate share of power and wealth. Multiethnic entities like the Russian Federation and the European Union seem well past their prime, leading to respectively aggressive and ineffective remedies to staunch the bleeding. The issues dominating the headlines are not ideological, but bureaucratic: U.S. tariffs on Chinese dumping of aluminum and steel, renegotiation of free trade agreements (including NAFTA and Brexit), monetary compensation for housing Muslim refugees (such as the EU-Turkey deal), and the Iran nuclear deal. This is not necessarily a good omen. A lack of ideology didn’t stop 20 million people from dying during World War I – and the ideologies that so ruinously dominated the world in the second half of the 20th century were born of that first epic global struggle. But World War I happened long enough ago that its lessons have mostly been forgotten.

Ideology vs. competition

Ideology is the terror that keeps liberals and conservatives, authoritarians and democrats awake at night. The West fears a return of the Soviet Union; Russia fears Western-backed regime change; everyone fears radical Islam, which ironically is currently the world’s clearest political ideology even if it is also the most brutal. It is important to understand this global reticence toward ideology, because what nations fear is the most powerful predictor of what they will do. But it is equally important to understand that these ideological forces exacerbated 20th century conflicts, they did not cause them. The root of these conflicts was competition between great powers, and the world is inching toward a new competition.

There is perhaps no better example for the tone-deafness surrounding ideology than American political discourse. During his time in office, former President Barack Obama was often called a socialist – by his enemies, who used it is as derogatory term, and by his supporters, who thought he would make America Sweden. President Donald Trump is routinely called a populist – by his enemies, who hate his demagoguery, and by his supporters, who appreciate his tough stance on immigration. None of the popular views of either of these men comports with reality. Obama was not a socialist – what leftist paragon would ever consent to bailing out multinational finance and insurance giant AIG? And Trump is no populist – what populist would claim that irrational highs in the stock market are good for low- and middle-income workers? In the U.S., political labels have become little more than vacuous ravings, to the extent that it is hard to know who stands for what anymore.

Tellingly, this is not just an American phenomenon. It is happening across the world, and in countries whose internal divisions could truly be regime threatening. China, Russia and Turkey are a few examples. It has meant tamping down public debate for fear of what that debate might unleash and installing conservative authoritarian personalities for fear of the alternative. All of this irrationality is just the manifestation of a deepening level of popular discomfort – a discomfort that reflects the diverging interests of the world’s nations. In a world where the future feels increasingly uncertain and where economic prospects for future generations are gloomy, frustration can easily be directed at the global superpower. This superpower is seen as possessing an unfair share of money and power, which should be more equitably distributed. The global superpower itself simultaneously wants to be left alone and to maintain its position, which leads to erratic behavior, and the cycle spins on and on.

A great ideological struggle is not imminent; a new Iron Curtain is not about to descend on any of the world’s continents. There is a dominant world power and a second tier of both rising and falling powers that want the dominance of the U.S. curtailed and yet are not strong enough to realize that goal. This is creating disagreements, and there is a tendency to fall back on Cold War nostalgia to make sense of them. That is the wrong analogue. A more accurate analogue would be the latter half of the 19th century. It was a time of emerging great power competition, a time when relations between states were about national interests, not ideological righteousness. And yet even as national powers remade the world, human beings longed for ideology (or religion or science or any other worldview). They longed for ideology because it promised to make sense of the irrational and to give meaning to the mundane. And when war exploded, there was no shortage of ideologies available to the masses to make sense of the carnage.

In the current global structure, there is a dominant power, but it is increasingly challenged by other powers seeking to defend or achieve their national interests. As the world becomes more competitive and as it becomes more difficult for the average person to imagine that the present course will lead to a better tomorrow, the desire for ideology will rise. Ideology is not shaping bilateral relations because an ideology hasn’t emerged yet that has captured the spirit of the times. The world is still cycling through the old ones, attempting to understand the 21st century through the lens of the 20th century. That means we aren’t on the verge of the Second Cold War. Ideology is dead. Even so, we can already see the shape of new gods being created.

Illinois Enters Its Death Spiral

When an entity needs to borrow ever-greater amounts of money to survive, the markets – that is, the people who are being asked to lend the money – eventually rebel. This rebellion takes the form of rising interest rates as lenders demand a higher return to compensate for the extra risk, and falling credit scores as rating agencies are forced by the markets to face reality.

Then one of two things happens: Either the borrower gets its act together, finds the cash it needs internally and stops borrowing. Or the rising cost of new borrowing sends it into a death spiral that ends with some form of default, restructuring, or dissolution.

Illinois – and its basket case of a city Chicago – are deeply into this process and show no signs of pulling out. Both city and state need ridiculous and growing amounts of money to cover their ballooning pension obligations (which the courts won’t let them cut), and now have to pay rates that make a course correction mathematically impossible. Here’s the latest:
Illinois’ upcoming $500 mln bond sale gets near-junk rating
(Reuters) – Moody’s Investors Service on Thursday rated $500 million of bonds Illinois plans to sell this spring one notch above junk, citing the state’s big unfunded pension liability and chronic budget déficits. 
The credit rating agency assigned the state’s current Baa3 rating to the general obligation bonds. Illinois’ first bond issue this year will be sold competitively with the proceeds earmarked for capital and information technology projects, according to a state official familiar with the sale. A pricing date was not available. 
Moody’s said the rating outlook remains negative, “based on our expectation of continued growth in the state’s unfunded pension liabilities, the state’s difficulties in implementing a balanced budget that will allow further reduction of its bill backlog, and elevated vulnerability to national economic downturns or other external factors.” 
It warned the rating could be downgraded to the junk level if Illinois’ unpaid bill backlog increases, pension funding is reduced, or if the state is unable to manage impacts from a future recession, trade war or reductions in federal funding for Medicaid. 
Illinois, the lowest-rated U.S. state, sold $6 billion of GO bonds in October to reduce an unpaid bill backlog that ballooned to a record $16.67 billion last year. It also sold $750 million of GO bonds in November to fund capital projects and information technology. 
Investors are demanding higher yields for Illinois bonds than for GO bonds issued by other states. Illinois’ so-called credit spread over Municipal Market Data’s benchmark triple-A yield scale has widened from 177 basis points in early January to 208 basis points as of Wednesday.
(Bloomberg) – Illinois’s finances are so troubled that investors can make nearly as much money betting on the worst-rated U.S. state as they can on the American Dream mall project, perhaps the most despised structure in New Jersey. 
An unfinished, multicolored hulk in the Meadowlands beside the Turnpike, former Governor Chris Christie called it “the ugliest damn building in New Jersey, and maybe America.” Yet bondholders are asking to get paid nearly as much to own Illinois’s debt as they are demanding in return for holding the long-delayed mall’s unrated revenue bonds — a consequence of the state’s perennial budget distress that’s left it teetering near junk grade. 

The yield on Illinois general-obligation bonds that mature in 2028 averaged 4.5 percent in March, compared to an average of 4.99 percent on unrated bonds due in 2050 sold for the American Dream mall project, the shopping and entertainment center that’s years behind schedule, according to data compiled by Bloomberg.

This, remember, is during a long recovery in which most taxing authorities are raking in more than the usual amounts of money. If Illinois is near junk today, what will it be rated in the next recession when its tax take falls and its borrowing expands? Junk, apparently, which is another term for “non-investment-grade.” Buyers at that point will no longer be investing; they’ll be speculating.

For an idea of what this means, consider a pension fund, let’s call it the Public School Teachers’ Pension and Retirement Fund of Chicago, that invests in stocks (which fall during recessions) and high-grade bonds (which pay miniscule interest). Because currently employed teachers aren’t paying in enough to fully fund each year’s required increase in plan assets, the plan has to borrow to cover the difference. But because it’s a junk borrower, the interest it has to pay is higher than what it earns on its investment-grade bonds. So it generates a negative spread, increasing its underfunding from already-catastrophic levels.

With baby boomer teachers retiring en masse and demanding what they’ve been promised, what was once an accounting issue becomes a cash flow issue, in the sense that there is literally not enough cash to pay current bills. And that’s the end.

It’s not clear what happens next because states technically can’t go bankrupt. But whatever it’s called, the result will be some sort of default. And the market’s reaction will, as with all big failures, be a sudden burning interest in who’s next. That search will turn up plenty of cities and a few states, and we’ll have the catalyst for the next crisis.